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The road to shareholder value in the land of the rising sun

The road to shareholder value in the land of the rising sun

21-12-2016 | Insight
  • Michiel  van Esch
    Michiel
    van Esch
    Specialist Governance and Active Ownership

A wind of change in Japan

During the last quarter of 2015, Robeco conducted an extensive research to prepare for an engagement program with Japanese companies to enhance their corporate governance. Over recent years the Japanese government under leadership of Shinzo Abe has implemented several policies to strengthen the Japanese economy. One of the aims of the government has been boosting the Japanese stock market by making Japanese equities more appealing to international institutional investors. Return on equity for Japanese companies has been relatively low compared to their US and European counterparts.

To make the Japanese stock market more interesting for investors, several efforts have been made to improve the corporate governance of companies in Japan. Examples of such efforts are the Japanese stewardship code, encouraging institutional investors to engage with their investee companies and the Japanese corporate governance code, setting “comply-or-explain” guidelines for sound corporate governance practices for corporates. As these principles are largely of voluntary nature and broad in their guidance, there is a lot of freedom for companies in their implementation of these policies.

We believe that improvements in corporate governance practices can improve transparency, effective oversight and further alignment with interests of minority shareholders. Such changes would protect our investments in Japanese companies, and could contribute to stronger financial results. Therefore we have started an engagement project to improve governance practices for some of our investments. After a year of engagement, we report some of our first findings of this project.

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Board structure as a focus

Much of the corporate governance reform is focused on having more independent directors on the board. Indeed, we have noticed an increase in the number of independent members in Japanese corporate boards, or outside directors as they are often referred to in Japan. Whereas prior to the corporate governance reform, companies would usually have one outsider or even none, over 80 per cent of Japanese listed companies have at two or more outside directors, as recommended by the Tokyo Stock Exchange.

We support the trend for more independent directors, but at the same time we are unsure if the independent directors being nominated are always suited for their role. When the board of 7&I opposed the previous CEO on the strategic plan for the company, the CEO stepped down and the company reviewed its strategy. Later we learned that it was mainly the non-independent, or inside directors, who opposed the CEO. In our view, the role of outside directors includes being the leading voice in challenging management when top executives are underperforming, or when the business strategy management carried out is not leading to long term value creation. With many companies in our program we hear similar examples. Therefore it is of key importance that the independent board members have sufficient understanding of the business, the economic environment the company is operating in and financial knowledge to determine which decisions add value for shareholders and which decisions do not.

For shareholders it is very difficult to grasp the actual dynamics in a board. One of the provisions in the corporate governance code asks companies to do a self-evaluation and report to shareholders on this process. If done correctly such evaluations might help shareholders understand better the quality and the changes in the board of their investee companies and have a more fruitful conversation on the topic.

During our conversations with corporates we also note that many boards are slowly changing their way of working. Japanese boards are known to have weekly meetings and making decisions on a large degree of operational, day-to-day management issues. However, we start to see a shift towards monthly meetings that focus on strategic issues and their oversight duties. However, for most companies there still is a long way to go before they become well adapted to this new approach to corporate board roles. From our discussions, it is clear that this transition is an ongoing struggle for many companies.

A one size fits all corporate governance report

Over the last year we have seen many Japanese corporates provide so-called corporate governance reports that help companies report on their compliance with the corporate governance code. The corporate governance code suggests that companies should be disclosing how companies deal with a range of issues relevant for shareholders, including dividend policies, capital management, cross holdings, anti-takeover measures and remuneration structures. In our analysis of these policies we often find that many companies publish documents that provide little concrete information and the text of the policies between companies are suspiciously similar. Often we find texts like: “The management might hold cross holdings in a range of companies, if management deems the holdings beneficial to all stakeholders. Cross holdings are reviewed annually.” This might lead one to think that corporates are publishing corporate governance policies as a compliance exercise, but from our engagement we know that most companies are thinking how to address these issues and just need more time to understand what policies are appropriate.

Communication with investors is improving, ….slowly

Many international investors face troubles in getting all relevant information of Japanese corporates. Often this has to do with language issues, leading to nuances getting lost in translations. Additionally, Japanese companies often do not have Investor Relations departments. The perception of many investors is that communication with investors are not a priority for Japanese companies compared to other stakeholders such as customers, clients or suppliers. At the same time, Japanese corporates often complain that their investors do not sufficiently understand the business and are too short sighted to engage in a constructive dialogue.

In our engagement work we note that communication between Japanese corporates and their investors is improving. However, it is of key importance for investors to prove that they are long term oriented, have a constructive attitude and take the effort to understand the cultural context of how companies are run. Once such a relation is established, engagement can be very productive. One great example is our engagement with Asics. It took us a while to get in touch with this apparel manufacturer, but we have been able to grow a constructive exchange of ideas on corporate governance reporting, remuneration and anti-takeover provisions. Another example is Mizuho Financial, who proactively asked shareholders for feedback on their capital management policies after seeing a shareholder proposal from an activist investor on the company’s dividend policy gain 49% of shareholder support.

Japanese companies appear to be opening up to shareholders and are becoming more willing than before to discuss governance reform. Even though many shareholders are impatient with the speed of governance reform, things are slowly changing in corporate Japan.

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